Updating Allowance Allocations in Cap-and-Trade: Evidence from the NOx Budget Program

Abstract

The level and distribution of the costs of tradable allowance schemes are important determinants of whether the regulation is ultimately enacted. Theoretical and simulation models have shown that updating allowance allocations based on firm emissions or output can improve the efficiency of the scheme by acting as a production subsidy. Using the U.S. NOx Budget Program (NBP) as a case study, this analysis tests whether power plants in states which chose an updating allocation increase their electricity production relative to plants in states that chose a fixed allocation. Results find that updating allocations led to a 5 percentage point increase in capacity factors for natural gas combined cycle generators and no effect or a modest decrease for coal generators. These findings imply that an updating allocations confers a modest but meaningful subsidy to production relative to a fixed allocation and that firm responses are heterogeneous based on production technology and market conditions.

Keywords: updating allocation, tradable permits, electricity

JEL Classification: Q480